| 2013-09-12

Cash flows more difficult for big pharma

Big pharma firms have between US$20b and US$40b of cash unnecessarily tied up in WC processes, equivalent to between 3.6% and 7.1% of their aggregate sales

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According to EY Cash on prescription study, big pharma’s WC performance in 2012 show a further, albeit more modest, deterioration from the prior year.

However, these generally poor WC results mask a much stronger management focus on cash and WC in recent years, as companies have sought to optimize capital and grow shareholder value. Significant progress has already been achieved in some areas of WC, but its impact has not been enough to offset the adverse effect on the industry’s overall performance of changes in distribution arrangements and transformation of its business model.

A challenging environment for big pharma, marked by a drop in sales and WC levels: Compared with 2011, big pharma’s sales declined by as much as 3% in 2012, due to increased competition from generics, pressures on pricing and the negative impact of exchange rates for companies reporting in US dollars (which accounted for two-thirds of total industry sales). These forces more than offset the ongoing development of rapidgrowth markets. Demand for consumer health care products also weakened significantly in the second half of the year, notably in the US and Europe. Merger and acquisition activity was limited. Against this backdrop, WC levels also dropped, but at a pace (-2%) that was a little slower than for the decline in sales.

Wide range of payment practices

Wholesalers are generally the quickest payers for pharmaceutical products, while hospitals and government agencies tend to pay later. For US wholesalers, the average payment period (DSO) is 35-45 days. Europe shows wide variations in payment terms across wholesalers, with a small number of them dictating the overall level for each country. Germany and Scandinavia exhibit the lowest DSO (25-35 days). In the UK, the range of payments has widened to 60-90 days. In Japan, DSO remains high, at 90-120 days, while in the rest of the world, there is a wide distribution of DSO performance, reflecting varying levels of market maturity, local payment practices and commercial strategies.

Besides wholesalers, pharmaceutical companies in Europe deal with a mix of doctors, pharmacies, hospitals and government buying agencies, which results in extended payment terms, high levels of overdue payments, and high logistics and distribution costs. For this segment, DSO can be estimated at 70-80 days, with wide variations across categories and within each country.

„If until now, all European Union member states were obliged to pay the drug bills within 30 days, Romania was required to pay the bills to drug distributors within 180 days, which is a six times pay gap from the rest of Europe, although in reality in March 2013 the payment term for compensated and free drugs reached 360 days.

Although since March 2013 for invoices issued after this date, health care authorities had to reduce the payment term for these drugs at 60 days, in accordance with Directive 7/2011 of the European Union on combating late payment in commercial transactions, this directory is still extremely difficult to implement because it would mean for local authorities assigning of significant additional funds that at this moment they do not hold”, underlines Silvia Tălpeanu, Senior Manager, EY Romania.

As the pace and scale of change in the industry escalate, pharmaceutical companies seeking further progress in WC will need to respond to emerging operational and market issues with more substantial changes than they have to date.

„Firms should consider collaborating more closely with wholesalers and other distributors; building greater responsiveness into systems and processes; achieving supply chain resilience; managing outsourcing more effectively; taking a balanced approach between cash, cost, service levels and risk; tailoring WC strategies to conditions in rapid-growth markets; and changing internal behaviors.

Also, pharmaceutical companies may be able to identify additional opportunities for WC improvement by examining the practices of leading WC performers in other industries, such as consumer product”, says Silvia Tălpeanu, Senior Manager EY Romania.

About the report

This report is based on a review of the WC performance of big pharma, which is composed of the 14 largest pharmaceutical companies (by sales) headquartered in the US and Europe, representing almost half of the world pharmaceutical market.